Wednesday, May 13, 2009

Two related stories signaled investors today to push the dollar lower in overseas trading last night. First, former GAO chief David Walker notesa bond warning from Moody’s that US Treasury bonds may lose their top rating — and that could cost us dearly:

Long before the current financial crisis, nearly two years ago, a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us.

That warning from Moody’s focused on the exploding healthcare and Social Security costs that threaten to engulf the federal government in debt over coming decades. The facts show we’re in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.

Prices have risen on credit default insurance on US government bonds, meaning it costs investors more to protect their investment in Treasury bonds against default than before the crisis hit. It even, briefly, cost more to buy protection on US government debt than on debt issued by McDonald’s. Another warning sign has come from across the Pacific, where the Chinese premier and the head of the People’s Bank of China have expressed concern about America’s longer-term credit worthiness and the value of the dollar.

Why does McDonald’s make a better risk? McDonald’s doesn’t run massive deficits. And the Chinese are right to be worried about their investments, as the AP reports on how much worse those deficits will become, and much sooner than the political class admitted:

Social Security and Medicare are fading even faster under the weight of the recession, heading for insolvency years sooner than previously expected, the government warned Tuesday. Social Security will start paying out more in benefits than it collects in taxes in 2016, a year sooner than projected last year, and the giant trust fund will be depleted by 2037, four years sooner, trustees reported.

Medicare is in even worse shape. The trustees said the program for hospital expenses will pay out more in benefits than it collects this year, just as it did for the first time in 2008. The trustees project that the Medicare fund will be depleted by 2017, two years earlier than the date projected in last year’s report.

The trust funds — which exist in paper form in a filing cabinet in Parkersburg, W.Va. — are bonds that are backed by the government’s “full faith and credit” but not by any actual assets. That money has been spent over the years to fund other parts of government. To redeem the trust fund bonds, the government would have to borrow in public debt markets or raise taxes.

As the boss recalss this morning, George Bush tried in 2005 to warn about the looming crisis in entitlements. What kind of response did that get? Democrats like Harry Reid accused Bush of fearmongering and panic, and assured Americans that “the so-called Social Security crisis exists in only one place — the minds of Republicans. In reality, the program is on solid ground for decades to come.”

Obviously not. Last month, I noted several more of those Democratic demurrals in 2005, along with the news that Social Security surpluses have already disappeared. As I wrote earlier, Treasury’s website shows that we lost money in February for the first time ever — and that will only get worse as the economy slows, unemployment rises, and more people start drawing Social Security.

Why did this hit the dollar today? If the US loses its top rating as a bond issuer — which really only means as a borrower — we will have to pay higher interest rates on our bonds in order to attract investors. This has already started to happen even with the top rating, but a markdown will force the issue. That will make our debt service significantly higher than we anticipated at either the OMB or the CBO, and these deficit projections will start extended a lot farther downward in the next couple of years:

Not only will the deficits increase, the cost of deficits will increase, and eventually the debt service will become the biggest part of the federal budget — unless Washington massively increases taxes to close the gap.

And that is why Tea Parties have erupted across America. The free-spending policies of today will lead to massive taxation or collapse in the near future, and anyone with a calculator and an iota of sense can see it. Click to read the rest of the article and the comments